Investing nowadays is a tough job due to high levels of uncertainty. Valuation guru Aswath Damodoran expressed his views on how to get rich now.
Investing in the past
I previously wrote about Warren Buffett’s strategy and how it changed. The legendary investor used to follow Benjamin Graham’s approach to stock picking. It was largely quantitative, as it relied on purely financial data. Graham did not use any qualitative information, like a company’s competitive landscape or its product portfolio diversification to make investment decisions.
But after having left Graham’s company – Buffett used to work there as an employee – he formed his own company, Berkshire Hathaway. He summarised his investment approach as “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price”. In other words, it’s better to buy a great company with a wonderful potential than a cheap but average company.
Damodoran, an equity valuation guru, also used to have a rather numerical approach. In his book, Investment valuation, he explains things like discounted cash flows, price-to-earnings (P/E), and price-to-book (P/B) ratios. Most of this book’s chapters are devoted to evaluating accounting data rather than growth prospects.
Companies with lower debt levels, lower P/E and P/B ratios, as well as stable cash flows prove to be less of a risk and better value investments.
What Damodoran says now
However, in an interview to ETNow, Damodoran said that the last decade and the COVID-19 crisis have meant that old-style value investing has no meaning these days. In other words, in order to decide whether to invest in a company, you have to understand the company’s success story, not just the mechanical numbers such as P/E and P/B ratios.
What is meant by the success story? Well, it’s not just the history of a firm. It also involves analysing the industry’s overall chances to excel and the company’s competitive landscape. Understanding the firm’s product portfolio and how much each product contributes to the sales revenue is also important.
Last but not least, the quality of the company’s management greatly helps a company to succeed. It is particularly important when a firm has to navigate through crises. Another problem that can happen to a company and where management can be a great help is when products that a company sells become out of date. For example, when smartphones became the new norm, many electronics companies had to adapt to this. Firms that failed to do so lost a large share of their sales and profits.
How to get rich now
All this doesn’t mean that you have to rely on purely qualitative information when you buy shares. Instead, it is worthwhile to combine the two approaches mentioned above. To be a great investor, you have to see the big picture of the company, its financials, its future, and the industry as a whole.
Damodoran also makes an interesting point that every crisis doesn’t just produce losers, it also producers winners. So, if a company is big enough in size, it is likely to survive as smaller competitors go out of business. It was the famous dot-com bubble that led to the rise of Amazon. Likewise, the coronavirus crisis will also produce true winners.
In my view, FTSE 100 investors will get rich and retire early if they choose large companies with great success stories that are also relatively cheap and pay dividends.